Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s will end by 2013. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 23 January 2012)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000, where "secular bear market" is defined as a long-term downward trend in valuations (P/E ratios, etc.) and gold-denominated prices. This secular trend will bottom sometime between 2014 and 2020. (Last update: 22 October 2007)

A secular BEAR market in the Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. This secular trend will peak sometime between 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the Continuous Commodity Index (CCI), commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

QE3 Update

It is taking longer than expected for the new "QE" program announced by the Fed on 13th September to have a meaningful effect on the Fed's balance sheet and hence on the US money supply. As far as we know, this is due to the delay between when the Fed arranges to buy some MBS (Mortgage Backed Securities) and when payment in the form of newly created money is issued to the seller of the MBS. This delay can apparently be as much as a couple of months. That being said, evidence of the Fed's new inflation program has started to emerge.

The Fed's balance sheet is roughly the same size now as it was at the completion of QE2 way back in early July of 2011. This means that the Fed has made no direct contribution to the US money supply over the past 16 months. However, if we zoom in on the recent past it becomes clear that the money pumps are being cranked up. We note, in particular, that the Fed's balance sheet has expanded by $53B since 12th September. This is a lot less than the $40B per month stipulated under the latest QE program, but as we said above the difference can probably be put down to settlement delays. From now on we should see an average of about $40B per month added to the Fed's balance sheet as purchases agreed over the preceding two months are settled by issuing new money.

This money pumping WILL cause some prices to rise. 

Political/Country Risk

Behre Dolbear, a well-respected international consultant to the mining industry, puts out an annual political risk assessment covering the most important countries for mining. The table displayed below is a summary of the 2012 assessment. The table is ordered from most risky (lowest point score) at the top to least risky (highest point score) at the bottom. Note that despite possessing considerable mineral wealth, Zimbabwe and Venezuela aren't included in the table due to their inherently low ranking.



According to Behre Dolbear, these are the five riskiest countries to operate or develop a mine:

Russia
Bolivia
D.R.C.
Kazakhstan
Papua New Guinea

And these are the five countries that Behre Dolbear considers to be the most attractive from a political risk perspective:

Australia
Canada
Chile
Brazil
Mexico

Wherever possible, investors should limit themselves to the stocks of mining companies that have their main assets in relatively low-risk countries.

A final point worth mentioning is that political risk is often not uniform throughout a country. For example, Canada is generally (and correctly) considered to be a relatively low-risk country, but some Canadian provinces are more mining-friendly than others. All else being equal, an exploration-stage mining project will have a better chance of moving through to production if it is located in the Canadian province of Quebec than if it is located in the Canadian province of British Columbia.

The Stock Market

A buying opportunity in the O&G (Oil and Gas) services sector?

Water management is a big deal for the companies using horizontal drilling and multi-stage fracturing to extract oil and natural-gas from shale formations. And Poseidon Concepts (PSN.TO), a supplier of fluid management services (water storage tanks, mostly) to the O&G industry, positioned itself to capitalise on the rapidly-growing needs of O&G drillers for more water and more efficient methods of water storage. PSN's business expanded at a fast pace and its future looked extremely bright ... right up until about 5.00PM last Wednesday when it published its latest quarterly results. The quarterly results revealed several problems, chief among them being that a business that was widely expected to achieve additional strong growth had begun to shrink. Other problems revealed by the quarterly results were a substantial decline in profit margin and a blow-out in receivables.

The stock market reacted to the quarterly report by lopping 62% off PSN's market capitalisation last Thursday (see chart below). This was one of the most sudden and spectacular falls from grace we have ever seen. 50%+ single-day declines aren't rare in the world of high-risk microcap mining stocks, but this was a stock with a very profitable business, a billion dollar market cap, a strong balance sheet and an 8% dividend yield that didn't appear to be vulnerable to 'bolts from the blue'.



Upon noticing PSN's collapse last week our first thought was that it might make sense to buy the stock in anticipation of a rebound. Our thinking was that a return to double figures wouldn't happen anytime soon, but a rebound that retraced only half of Thursday's decline would result in a profit of around 80% for anyone who bought the stock near Thursday's closing price of $5. However, we would only have attempted such a trade if we were confident that the market had discounted the worst-case scenario, which we weren't/aren't. Despite the huge sell-off, the stock did not appear to be cheap at C$5.00 if we made the realistic assumption that further deterioration of the underlying business lay ahead.

Our second thought, which occurred after we read through the PSN press release that sparked the collapse, was that this does not augur well for the entire O&G services sector. You see, PSN's revenues and margins didn't fall due to inroads being made by its competitors; they fell due to an industry-wide downturn. As stated by PSN:

"The combination of declining rig counts, delays to completion programs and, ultimately, lower capital spending by exploration and production companies attempting to rationalize service costs and stay within reduced 2012 budgets meant lower utilization and pricing for Poseidon's tank fleet."

And: "The impact of the slowdown became evident to Poseidon in the second half of the third quarter. Throughout the North American oil field service industry, several fracturing-related and ancillary rental services experienced significant spot market pricing declines, and Poseidon was not completely immune to the adverse conditions."

And: "Poseidon's tank utilization and revenue in the quarter were further affected as the company renegotiated terms on several long-term agreements with specific, strategic customers due to changes in their project schedules and capital budgets. Meanwhile, several other long-term agreements lapsed without renewal or were suspended as certain customers' activities were reduced due to macro considerations or capital budget constraints."

In late June we suggested 'going long' the O&G services sector -- via OIH and/or PDS -- for a trade. That worked well. With the prices of most O&G services stocks having pulled back considerably over the past two months (as evidenced by the following daily chart of OIH) we were starting to think that the same short-term trade could be in the offing, but the PSN news indicates otherwise. At this stage there is too much scope for unpleasant surprises. Lower prices will be needed to create a suitably attractive risk/reward.



Current Market Situation

The McClellan Oscillator is a useful indicator, but only when it reaches an 'oversold' extreme. Most of the time it can safely be ignored.

The percentage of SPX stocks above their respective 50-day moving averages is similar, in that it provides useful information at 'oversold' extremes and at no other time. The following chart shows that this indicator hit a low of 23% last Thursday before recovering a little to end the week at 26.6%. Like the McClellan Oscillator it is getting close to the sort of extreme that would point to a market bottom of at least short-term significance, but it isn't there yet.

The "SPX Stocks Above 50-EMA" indicator will generate a reliable signal that the market is close to a multi-month low if it moves below 15%.



Below is a chart of the HYG/TLT ratio -- one of our favourite indicators of risk aversion. When high-yield bonds (represented by HYG) are rising relative to Treasury Bonds (represented by TLT) it suggests that the average market participant is becoming less risk averse. In other words, it suggests that the markets are in "risk on" mode. And when Treasury Bonds are doing better than high-yield bonds we can conclude that the markets are in "risk off" mode.

The financial markets were clearly in "risk on" mode from August of 2010 through to the first quarter of 2011 and were clearly in "risk off" mode from April-May of 2011 through to November of 2011. However, over the past 12 months the risk trend hasn't been clear. This reflects the counteracting forces in play. Central banks are encouraging investors to take more risk and are periodically having some 'success', but then attention shifts to the economic depression in some euro-zone nations and/or China's slowdown and/or the US "Fiscal Cliff".

We suspect that a multi-month period of "risk on" will begin in the near future, but to set the stage for such a period there could (ideally will) first be a final 'whoosh' in the stock market. We aren't talking about a crash, just a sharp multi-day decline that pushes the senior stock indices to 'oversold' extremes.

This week's important US economic events

Gold and the Dollar

Gold

Gold drifted relentlessly lower over the course of last week, but only gave back about half of what it gained the previous week. By falling last week at a slower pace than it rose the week before last, the gold market provided us with some additional evidence that the recent decline to the $1670s marked the end of the correction that started shortly after the QE3 announcement.

The price-related evidence of a correction low is not conclusive and it is obviously not a plus that the bullish divergence between the XAU/gold ratio and the gold price was eliminated last week, but the price-related evidence will only become conclusive after the price moves a lot higher and the vast majority of significant gold bottoms over the past several years were not accompanied by bullish divergences between the bullion and the mining stocks. It would have made things easier if the bullish divergence between the stocks and the bullion had remained intact, but such a divergence is certainly not a prerequisite for a correction low in the bullion market.



In addition to the odds being in favour of a correction low in the gold price, they are also in favour of a correction low in the silver/gold ratio (see chart below).

When the silver/gold ratio begins to trend downward it usually doesn't leave us guessing for long, in that it tends to fall hard and fast soon after making an important top. With reference to the following chart, notice, for example, the three plunges that occurred last year. Now compare last year's price declines with the decline of the past several weeks. At this stage the decline from the September-2012 short-term top has the look of a normal correction within an upward trend.



Gold Stocks

In last week's Interim Update, we wrote:

"...with very few exceptions the price action during any single trading day will tell you precisely nothing about the future. One of the rare exceptions entails a market experiencing a pronounced single-day reversal after moving relentlessly in one direction over a period of at least several weeks. For example, the gold-stock indices have now been trending downward for almost two months and have just fallen for four days in succession. If they were to fall on Thursday 15th November (making it five down-days in a row) and fall again during the first hour of trading on Friday before reversing upward and ending the day with a solid gain, then Friday's price action would be a short-term bullish omen."

As it turned out, the gold-stock indices fall on Thursday 15th November (making it five down-days in a row) and fell again during the first hour of trading on Friday before reversing upward, but Friday's gain was too small to be considered reliable evidence that a sustainable low is in place. That doesn't mean that a sustainable low wasn't put in place late last week, only that such a low hasn't yet been signaled by the price action. A low could be signaled by a strong (>3%) rise in the HUI on Monday 19th November or a spike below last week's intra-day low followed by a reversal that leads to a gain at the end of the trading day.

The current situation is that the HUI has fallen further than we thought it would and become more 'oversold' than we thought it would during the predictable correction from its September high. However, the more bearish short-term outcome has increased the probability of a more bullish intermediate-term outcome. This is because there is no longer any chance of an intermediate-term peak during November-December of this year. By far the most likely intermediate-term scenario is that the current correction will be followed by a rally that lasts until May-June of 2013 or later.



The following chart shows the GLDX/GDX ratio, which means that it shows how exploration-stage junior gold stocks have performed relative to major gold stocks. Between February of 2011 and June of 2012, the exploration-stage juniors represented by GLDX lost almost 50% of their value relative to the major gold stocks represented by GDX. Since June of 2012 the juniors have essentially held their own relative to the majors, but at this stage there is no evidence that the intermediate-term trend has reversed direction.



A seasonal period of relative strength in the juniors begins late in the 4th quarter and extends through to at least February of the following year. Last year's seasonal strength in the juniors was smaller than average in terms of both duration and magnitude, but it was still evident. If the overall gold sector commenced a 1-2 year upward trend in May of 2012 (the most likely scenario, in our opinion), then the seasonal rally that begins between now and year-end should be at least as good as average.

We continue to like GLDX for a 3-5 month trade.

Currency Market Update

The Yen dropped quite sharply last week as the market anticipated more aggressive attempts to inflate by the Bank of Japan. Other than that, very little happened in the currency market.

In a classic example of "buy the rumour sell the news", like most beneficiaries of US$ inflation the euro rallied hard during the weeks leading up to the Fed's "QE3" announcement and has been working its way downward since the day after "QE3" was formally introduced. Our view is that the euro has unfinished business on the upside and that this unfinished business will be taken care of after the stock market reaches a short-term bottom. In other words, we expect the euro to move above its September high before it commences its next intermediate-term decline.



The Canadian Dollar (C$) has also pulled back since the QE3 announcement and should also rally after the stock market reaches a short-term bottom. However, for two reasons we suspect that the C$'s September peak will turn out to be the intermediate-term variety. The first reason is that the price action looks more like the initial leg of a new intermediate-term decline than a consolidation within a continuing upward trend. The second reason is that despite the price decline, the COT data and Market Vane's sentiment survey indicate that speculators have remained steadfastly optimistic about the C$'s prospects. This sort of mismatch between sentiment and price action is bearish.

In other words, the next short-term C$ rally will probably end below the September high.

Update on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Company news/developments for the week ended Friday 16th November 2012:

[Note: FS = Feasibility Study, IRR = Internal Rate of Return, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Batero Gold (BAT.V) reported the second and final batch of results from its 2012 drilling program. The best gold intercepts from this batch of 28 holes were 143m grading 1.36-g/t, 96m grading 1.2-g/t and 83m grading 1.07-g/t. In each case the gold mineralisation started at or just below the surface.

BAT is focused on the top 200m of the La Cumbre deposit (the part of the deposit that contains oxidised and transition ore) at its 100%-owned Batero-Quinchia project. The next step will be the preparation of an updated resource estimate, which is scheduled to be complete by early 2013. This resource estimate and on-going metallurgical testing will form the basis of a mine plan and economic analysis for a starter pit.

Thanks to the recent investment by Peruvian gold miner Consorcio Minero Horizonte (CMH), BAT is now well positioned to advance the La Cumbre deposit to the point where a mine-construction decision can be made.

  *Elgin Mining (ELG.TO) reported its results for the September quarter. After incurring disappointingly high production costs at its Bjorkdal mine during the June quarter a significant reduction in costs was necessary during the September quarter for the stock to maintain its speculative appeal. A significant cost reduction happened (the cash cost fell by about 11% from the previous quarter). Consequently, the Bjorkdal mine in Sweden generated enough cash to mostly offset the exploration expenditure at the company's projects in Canada.

We expect to see a further improvement in the profitability of the Bjorkdal mine during the December quarter due to increased production and lower cash operating costs. This could lead to a good selling opportunity after the December quarter results are reported next February.

  *Endeavour Mining (EDV.TO, EVR.AX) continues to fire on all cylinders. The company reported last week that its operations in Ghana and Burkina Faso generated about $41M of cash during the September quarter and are on track to produce 200K ounces of gold this year at a cash cost of $670-$690/oz. The stock is trading at about 6-times this year's cash flow and cash flow is set to increase substantially in 2013 and again in 2014. The stock is a buy below C$2.20.

  *Golden Predator (GPD.TO) reported that the Alligator Ridge Area of Barrick Gold's Bald Mountain mine has P&P Reserves of 652K ounces of gold. GPD owns a 1% Gross Sales Royalty (GSR) covering these reserves. GPD also owns a 4% GSR covering the Duke-Trapper-Royale portion of Barrick's Bald Mountain mine. An independent resource estimate commissioned by GPD for the Duke-Trapper-Royale portion is scheduled to be complete in Q2-2013.

As mentioned in the past, the main reason for our interest in GPD is its royalty portfolio.

  *International Tower Hill Mines (THM) published its financial results for the latest quarter. Of greatest relevance, the company had about $35M of working capital at 30th September. It expects this to be sufficient to fund the completion of the Livengood FS (due H1-2013) and for general working capital purposes through 2013. Our guess is that the next equity financing will occur in Q2 or Q3 of next year.

  *Pilot Gold (PLG.TO) reported additional drilling results from its TV Tower project in Turkey. The results were good, with the highlights being 11.63 g/t gold over 32.5 metres, 3.40 g/t gold over 87.0 metres, and 10.03 g/t gold + 46.25 g/t silver + 3.89% copper over 15.2 metres. Assays are pending for 21 completed holes, so more drilling news should be forthcoming within the next few weeks.

  *Pinetree Capital (PNP.TO) announced that its NAV was C$1.71/share as at 31st October 2012. Based on how the markets have performed since 31st October, we estimate that its NAV is presently about C$1.60/share. This compares to Friday's closing price of C$0.95/share.

PNP is similar to GLDX in that it is effectively a diversified play on exploration-stage mining stocks. However, PNP is riskier and more highly leveraged.

  *Rio Novo Gold (RN.TO) reported that it had about $9M of working capital as at 30th September. The company is therefore in no danger of running out of money in the near future, but $9M is nowhere near enough to cover the equity portion of the $150M of financing needed to construct the Almas gold mine in Brazil.

  *Sabina Gold and Silver (SBB.TO) reported the final results from its 2012 drilling program at the Back River project. The highlight was a hole grading 24.20g/t over 25.45m from one of the George deposits. The next news of significance from SBB will probably be an updated resource estimate early in 2013.

SBB is suitable for new buying near its current price in the C$2.70s.

  *Sandspring Resources (SSP.V), a tiny company with a 10M-oz gold deposit in Guyana (the Toroparu project), reported its results for the September quarter. Of particular interest to us, at 30th September the company had $14M of working capital. Based on its budgeted expenses over the remainder of the year we estimate that it will end the year with about $7M of working capital. This probably means that SSP will have to do another equity financing around February-March next year.

Also of interest to us was the following excerpt from the company's MD&A:

"Mr. Roditis [SSP's new COO] will begin by overseeing the ongoing optimization of the Toroparu operating plan, which includes the evaluation of a number of scenarios based on selective mining of the higher grade core of the Toroparu deposit instead of bulk mining the resource as previously defined. The objectives of the optimization include defining an operation that provides a smaller initial project capital cost and a capability to expand to optimal throughputs financed from internally generated cash flow while maintaining life of mine gold and copper production ranges reported in the Company’s updated preliminary economic assessment."

It's good news that the company is shifting the focus of its mine planning to a smaller and higher-grade operation with a lower capital cost.

Based on the above-mentioned shift in focus and Hochschild Mining's recent purchase of the large low-grade gold deposit of Andina Minerals (the Hochschild-Andina news shows that large/low-grade gold deposits are still capable of attracting the attention of major or mid-tier miners if they are cheap enough), we are going to persevere with SSP for now.

  *UEX Corp. (UEX.TO) reported another interesting uranium intercept (19.9 Metres Grading 1.55% U3O8) from drilling at the new Kianna East discovery at its Shea Creek project. The uranium sector remains in the doldrums with good news generally being ignored by the stock market.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.decisionpoint.com/